Wintry Feel: Hawkish Fed, Rising Producer Prices Give Market a Chill

The market starts Friday with pressure expected, in part due to the Fed’s expectations of more rate hikes and from a wholesale inflation report that showed prices climbing more than analysts had expected.

Key Takeaways

Market tone looks weak to start day as investors seem focus on further rate hikes

Europe, Asia both fall across the board, with hawkish Fed language a possible factor

Earnings news has been mixed over the last day, with retail earnings ahead next week

(Friday Market Open) As the first snowflakes of winter fall in parts of the country Friday, the stock market also has a chilly tone to start the day. Concerns about rising rates continue to weigh on sentiment, and so does a higher than expected read on U.S. inflation.

Some investors seem to be seizing on what looked like an unremarkable aspect of the Fed’s statement yesterday, one that was unchanged from the previous meeting. The Fed said it expects “further, gradual increases” in rates as the economy continues to thrive. It’s a bit hard to understand any panic about these words, because they didn’t tell investors anything that most didn’t already know. Still, perhaps some people had hoped for a more dovish tone after October’s market thrashing and the Fed didn’t deliver. As it is, markets fell across Europe and Asia overnight, and pressure might spill over into U.S. trading.

Speaking of Europe, there’s more drama there as the European Commission tangled with Italy over the Italian government’s budget forecasts, which the EC said looked too optimistic on deficits. Moving west, debate raged about whether a Brexit deal might be getting close, and the U.K. government is holding meetings on the issue this weekend, media reports said. A Brexit breakthrough, if it comes, might give European markets a boost. But it’s unclear how close it might be. Asian markets are on pace to fall for the sixth week out of the last seven.

Back home, a slew of Fed speakers march out to the microphones today, so consider watching for some of their reflections. Michigan sentiment is also due this morning. Additionally, in a report that might keep the Fed on its toes, producer prices shot up by 0.6% in October—the biggest monthly climb in six years and way above analyst estimates of 0.2%. Higher gas, machinery, and equipment prices all played a part. However, it’s important to note that core wholesale inflation, which strips out volatile energy and food prices, rose a little less at 0.5%, and prices over the last year are up 2.9%, below the peak seen last summer. With oil now in a tailspin (see more below), inflationary worries might be lifting.

In earnings news late Thursday, Disney (DIS) delivered a strong quarter, posting earnings per share of $1.48 and revenue of $14.31 billion. Third-party consensus was for $1.34 and $13.73 billion. Both parks and resorts and the company’s studio-entertainment segments performed well, and the company predicted an accelerated timeline for its takeover of major assets of 21st Century Fox Inc. (FOX). According to DIS, the acquisition could close “meaningfully earlier” than the mid-2019 date it had previously projected, The Wall Street Journal reported. Shares of DIS climbed 1% in pre-market trading.

The news didn’t look so hot over at Activision Blizzard (ATVI), where shares crumbled 10% in the pre-market hours after the company missed analysts’ earnings expectations and saw active users fall.

Fed Reflection

Thursday saw stocks move a bit lower as the Fed held rates steady. Some of the pressure also might have reflected profit taking after a massive rally Wednesday that possibly got a bit overdone. Also, the Fed stuck to its position of advocating gradual rate hikes, meaning no sign of any end to the steady drip-drip of higher rates (this is the part that seems to be hurting sentiment early Friday). The Fed’s decision likely didn’t come as a surprise to many, but futures prices still predict around a 76% chance of a fourth 2018 rate hike by the end of the year. Fed Chair Jerome Powell is scheduled to make some public comments next week, which could give investors more insight into the Fed’s current thinking.

The Fed’s statement Thursday didn’t evolve much from its last meeting in September. As it did then, the Fed noted “economic activity has been rising at a strong rate,” and “job gains have been strong.” It added that the unemployment rate has dropped, and that household spending has “continued to grow strongly.”

Fed Sees Business Investment Moderating

The one significant change was around business investment, and that follows what looked like a slowdown in that category in the Q3 gross domestic product (GDP) report issued last month. “Growth of business fixed investment has moderated from its rapid pace earlier in the year,” the Fed’s statement now reads. Back in September, the Fed’s statement said that the category had “grown strongly.”

On the inflation front, there was no change to the Fed’s September prediction that price increases would remain near its 2% target over the next 12 months both for overall inflation and core inflation that strips out food and energy prices.

The Fed arguably finds itself in a tough place as it tries to keep the U.S. economy from overheating even as it faces pressure not to run the value of the dollar so high through tighter monetary policy that it might hurt foreign countries and keep their consumers from being able to afford U.S. products. Remember, the Fed has a dual mandate of stable prices and maximum employment. There are signs that a stronger dollar, along with recent trade battles, might be hurting U.S. company outlooks.

In Treasuries, the 10-year benchmark yield rose slightly to 3.23% after the Fed statement Thursday, just a few basis points below last month’s highs. It was at 3.21% early Friday.

Energy Loses Steam After Oil Craters

Energy shares took the biggest hit Thursday, falling more than 2% as crude oil entered a bear market (see more below). The dollar index is also back on the climb, moving above 96.60 Thursday after falling below 96 earlier this week. Hawkish Fed policy tends to support a strong dollar, and that could be a possible stress factor for some sectors like tech, industrials, and materials with big foreign markets. Also, the dollar is once again climbing vs. the Chinese yuan, with the psychological 7 yuan to the dollar level not far away.

Financials did appear to get a boost from the Fed’s continued optimistic tone regarding the economy, and topped the sector leaderboard Thursday. In fact, financials are outpacing the broader S&P 500 Index (SPX), over the last week. That’s kind of a change of pace, but it’s not clear if it can hold up. Bank stocks have declined about 7.5% so far this year, and just haven’t been able to get going despite this anticipated higher rate environment.

The stock market is out of correction, but the crude market turned bearish Thursday. U.S. futures closed below $61 a barrel on Thursday, down more than 20% from highs above $76 last month. Generally, a 20% drop from high close to low close defines a bear market. By early Friday, the front-month U.S. contract had fallen to $59.80, the first time a front-month has fallen under $60 since March 8. There hasn’t been a close below $60 in nearly nine months, so perhaps that’s worth watching later today. Thursday’s losses were the ninth-consecutive lower session for U.S. crude futures, with oil taking a beating from U.S. production hitting record highs and Saudi Arabia and Russia also gearing up output.

The long-term impact on the energy sector from all this is too soon to tell. One bad month probably isn’t going to make that big a difference, but extended periods of low oil prices can sometimes hinder energy sector earnings growth, as investors might remember from the bear oil market of 2015-2016. At that point, crude fell as low as $26 a barrel in the U.S., and many oil companies saw dramatic plunges in their earnings. It’s way too soon to worry about that now, and it’s also unlikely crude could fall to such bargain basement levels, especially considering how healthy the U.S. economy is now compared to then.

Figure 1: Extra Cash for Holiday Shoppers? This one-month chart comparing the consumer discretionary sector (candlestick) to the energy sector (purple line) shows that discretionary stocks are starting to rally back from October lows even as energy continues to wallow near recent lows. Cheaper oil is hurting the energy sector, but might end up helping discretionary by putting a little extra gas savings in holiday shoppers’ pockets. Data Source: S&P Dow Jones Indices.Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Lower Gas Costs Might Help Shoppers: Consumer discretionary has had its rally hat on lately ahead of holiday shopping season, and gas prices going back below $3 a gallon across much of the country over the last week probably can’t hurt this sector. Lower gas prices might have a psychological impact, making shoppers feel like they can spend a bit more on gifts if they’re saving at the pump (see chart above).

Stay tuned this weekend for an OPEC meeting. Some analysts think OPEC members might start sending signals soon about lowering output in the face of this price pullback, but that’s not assured. Others say Saudi Arabia may be under political pressure to keep the oil flowing after last month’s diplomatic dispute with the U.S. over a missing journalist.

Tech Recovery Beyond the Headlines: The FAANGS get a lot of attention, and all five of those closely watched stocks are up significantly from their October lows. Some have even gained in the double-digits. However, if you’re looking for the best performing tech stocks since October’s depths, you won’t find the FAANGs among them. Instead, tech leaders as of Thursday afternoon included semiconductor firm Advanced Micro Devices (AMD), up 34% from its October low, followed by a 30% gain from cybersecurity company Symantec (SYMC), and a 24% rise from Xilinix (XLNX), a supplier of programmable logic devices, CNBC noted. What this might help show is how varied the tech sector is beyond big names like Apple (AAPL), IBM (IBM) and Microsoft (MSFT).

From a high-level view, tech still trails the broader S&P 500 (SPX) over the last month. This partly reflects how so much selling zeroed in on tech shares during October’s shakeout. For the year so far, tech shares are still up more than 12%, compared with less than 6% for the SPX, but tech’s rise this year is way short of the better than 30% gains of 2017. Consider keeping an eye out for a couple of major tech earnings next week from Cisco (CSCO) and Nvidia (NVDA), which could give insight into the latest macro developments in those two companies’ respective industries.

Retail Stocks Perk Up Ahead of Holidays, Earnings: Black Friday is just two weeks away (less if you factor in that many stores actually throw open the doors late on Thanksgiving), and retail earnings season is also fast approaching. Next week brings Home Depot (HD) and Macy’s (M), along with Wal-Mart (WMT), Nordstrom (JWN), and J.C. Penney (JCP). So what do investors seem to think about how holiday shopping season might shape up? Judging from company share performance, the answer seems to be a thumbs up. Many big retailers have been outpacing the broader S&P 500 (SPX) since posting their October lows. As of midday Thursday, Macy’s shares were up 20% since the recent low last month; Amazon (AMZN) was up 20%, and Kohl’s (KSS) was up 18%. WMT didn’t seem to be affected much by the market sell-off in October, and is up 13% over the last month. The SPX is up about 8% from its October low.

On the whole, consumer discretionary stocks are slightly outpacing the SPX since early October. The outlier might be Apple (AAPL), which is actually a tech stock but obviously can have a huge impact on shopping season. The stock has made it back a bit after falling below $200 a share last week, but remains a long way from recent highs of around $230 as investors continue to debate what the company’s holiday quarter guidance and decision to stop reporting iPhone unit sales might mean moving forward.

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